S.E.C. v. STEFFES Case No. 10-CV-6266.
805 F.Supp.2d 601 (2011)
SECURITIES and EXCHANGE COMMISSION, Plaintiff, v. Rex C. STEFFES, Cliff M. Steffes, Rex R. Steffes, Bret W. Steffes, Robert J. Steffes, and W. Gary Griffiths, Defendants.
United States District Court, N.D. Illinois, Eastern Division.
August 3, 2011.
Constantine John Gekas, John Constantine Gekas, Gekas Law LLP, Simon B. Auerbach, Steffanie N. Garrett, Thomas R. Woodrow, Holland and Knight, LLP, Chicago, IL, David Dawson Burns, Gilbert Lee Feltel, Thomas Edward Bishop, Tanner Bishop, Jacksonville, FL, for Defendants.
MEMORANDUM OPINION AND ORDER
ROBERT M. DOW, JR., District Judge.
Before the Court are motions [29, 36] filed by Defendants W. Gary Griffiths ("Gary Griffiths") and the Steffes Family
I. Background 1
This case involves alleged insider trading in the securities of Florida East Coast Industries, Inc. ("FECI") in the period around that company's acquisition by Fortress Investment Group, LLC. The SEC alleges that Defendants Gary Griffiths and Cliff Steffes, who were employed by an FECI subsidiary, learned of FECI's pending acquisition in the weeks before it was announced, and that they disseminated this information to members of their family (who in turn shared it among themselves and with three business associates of Defendant Rex C. Steffes). In the weeks preceding the announcement of the acquisition, Defendants Rex C. Steffes, Cliff Steffes, Bret Steffes, Rex R. Steffes, Robert Steffes, as well as William Griffiths and the three business associates purchased more than $1.6 million of FECI securities. When the sale was announced, the investors collectively cleared more than $1 million in allegedly illegal profits.
Before its acquisition, FECI was a publicly traded company headquartered in Jacksonville, Florida. ¶ 17. FECI conducted business through two wholly-owned subsidiaries. Id. One subsidiary, Florida East Coast Railway, LLC ("FECR"), operated a regional freight railroad between Jacksonville and Miami. Id.
During the relevant time period, Griffiths and his nephew-in-law, Defendant Cliff Steffes, were employed by FECR. Griffiths was the Vice President and Chief Mechanical Officer of FECR. ¶ 11. Working out of FECR headquarters in Jacksonville, Griffiths was responsible for supervising and managing the leasing, maintenance and repair of freight cars and locomotives, and reported directly to FECR's President and Chief Operating Officer. ¶ 30. Defendant Cliff Steffes worked as a trainman at FECR's Bowden Rail Yard in Jacksonville. ¶ 13. Griffiths' sister is married to Defendant Rex C. Steffes, and Griffiths and Rex C. Steffes were high school classmates and have been good friends since the 1970s. ¶ 11. Rex C. Steffes is the father of Defendants Cliff Steffes, Bret Steffes, and Rex R. Steffes, and is the brother of Defendant Robert Steffes. Cliff Steffes obtained his position as a trainman with FECR with the help of his uncle, Griffiths. ¶ 31.
In connection with their employment, Griffiths and Cliff Steffes were both subject to FECI's Code of Conduct which prohibited them from trading in FECI securities, or recommending that others purchase FECI securities, if they had knowledge of material information about the company that had not been disclosed publicly. ¶ 32. FECI's Code of Conduct specifically provided that information regarding a merger or acquisition may constitute material information. Id. Griffiths and Cliff Steffes both signed acknowledgements that they would comply with FECI's Code of Conduct. ¶ 33.
On December 4, 2006, FECI's Board of Directors engaged Morgan Stanley & Co., Inc. ("Morgan Stanley"), to sell the company. ¶ 19. That FECI was being offered for sale was confidential. ¶ 20. Between February 15 and 27, 2007, Morgan Stanley contacted a group of prospective bidders,
The SEC alleges that "[b]y the end of the third week of March 2007, Gary Griffiths knew that FECI was in the process of being acquired by another company." ¶ 34. To support this allegation, the SEC alleges that Griffiths was aware of the following:
The SEC further alleges that "[b]etween April 19 and April 27, 2007, in anticipation of FECI's pending acquisition by Fortress, Gary Griffiths arranged and monitored the rail trip from FECR's Bowden Rail Yard to the Hialeah Rail Yard for FECI and Fortress executives in a special railroad car reserved for visitors." ¶ 35. Finally, the SEC alleges that Griffiths "had daily interactions with FECR's President and Chief Operating Officer, who knew about and was involved in the entire acquisition process." ¶ 36.
The SEC makes the same allegation with regard to Defendant Cliff Steffes: that by the end of the third week of March 2007, Cliff Steffes also knew that FECI was in the process of being acquired. ¶ 37. For his part, Cliff Steffes allegedly knew by the end of the third week of March 2007 that "there were an unusual number of daytime tours of FECR's Hialeah Yard involving a tour bus and people dressed in business attire." ¶ 37(a). Shortly after these tours began, rumors began to circulate that FECR was being sold. ¶ 37(c). The SEC alleges that "there were regular communications among FECR's yard employees at various locations, and many rail yard employees who had not personally witnessed the tours became aware they were occurring." ¶ 37(b).
Additionally, Steffes worked at the Bowden Rail Yard, which was the location of a tour that occurred sometime between April 19 and 27. ¶ 38. The Bowden Rail Yard was also the departure point for the special railcar trip for FECI and Fortress executives. Id.
The SEC alleges that between March 28 and May 7, 2007, there developed a pattern of conversations among the Defendants (and others) followed by large securities purchases that differed significantly from Defendants' prior purchases.
For example, between March 23 and March 25, 2007, Griffiths visited Rex C. Steffes (the elder Rex Steffes), during a
With respect to Robert Steffes (Rex C.'s brother), the SEC describes a similar pattern. Between April 2 and April 18, 2007, Robert Steffes purchased 5,000 shares of FECI stock for a total of $319,569. ¶¶ 49-50. Each of Robert Steffes' purchases was made shortly after a phone call between Rex C.'s and Robert's cell phones. Id.
On three different occasions in April and May 2007, Cliff Steffes purchased FECI call option contracts totaling $15,015 set to expire in June 2007. ¶ 39. These were the first stock option contracts that Cliff Steffes had ever purchased. ¶ 40. The SEC alleges that Cliff Steffes tipped his brothers, Bret and Rex R. Steffes. ¶ 55. Between March 29 and May 1, 2007, Bret Steffes purchased 60 shares of FECI stock and 112 FECI call options for a total investment of $30,775. ¶ 56. During this same period, Rex R. invested $31,018 in FECI securities. ¶ 58. Each of the brothers' purchases was made in temporal proximity to cell phone calls with Cliff. Bret and Rex R. were each provided with $10,000 from their father Rex C. to be used to purchase FECI securities; they each applied those monies towards their purchases. ¶ 55(c). The SEC alleges that each of Defendants' purchases was atypical of their trading histories. For instance, Bret and Rex R's purchases represented more than their 2006 annual incomes and nearly all of their liquid net worth. ¶¶ 60; 61.
By April 13, 2007, FECI had received nine separate acquisition proposals. ¶ 24. On May 6, 2007, Fortress submitted a definitive offer to purchase FECI for $3.5 billion for a payment of $84 per share, including the payment of a $21.50 special dividend. ¶ 28. FECI's board accepted Fortress's offer the next day. ¶ 28. FECI announced its agreement with Fortress on
Cliff Steffes sold all of his FECI call option contracts on May 8, 2007, realizing $51,935 in profits, a 346% gain. ¶ 42. Rex C. Steffes sold all of his FECI stock and call options on May 8, 2007, realizing $618,376 in profits, a 36% gain in one month. ¶ 48. Robert Steffes sold his securities on May 9, 2007 realizing $101,481 in profits, a gain of 32%. ¶ 52. Bret and Rex R. Steffes each experienced gains of over 300% after selling their FECI securities on May 8, 2007.
The SEC's one-count complaint alleges that Defendants Gary Griffiths, Rex C. Steffes, Cliff Steffes, Rex R. Steffes, Bret Steffes and Robert Steffes violated Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The SEC seeks a permanent injunction against all Defendants from future violations of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5. The SEC further requests that Defendants be ordered to disgorge their profits from the alleged insider trades and that they pay civil penalties pursuant to Section 21A of the Exchange Act, 15 U.S.C. § 78u-1.
II. Legal Standard
Defendants move to dismiss the complaint for failure to state a claim under Fed.R.Civ.P. 12(b)(6). A motion to dismiss tests the sufficiency of the complaint, not its merits. See, e.g., Gibson v. City of Chicago,
Allegations of securities fraud under § 10(b) and Rule 10b-5 fall under the pleading requirements of general fraud and must satisfy the heightened pleading requirements of Rule 9(b). See Fed.
Rule 9(b) states that for "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake" Fed.R.Civ.P. 9(b), whereas "[m]alice, intent, knowledge, and other conditions of a person's mind may be alleged generally." Id.
Section 10(b) makes it "unlawful for any person * * * [t]o use or employ, in connection with the purchase or sale of any security * * * any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe * * *." 15 U.S.C. § 78j(b). As promulgated by the SEC, Rule 10b-5 makes it unlawful for any person:
17 C.F.R. § 240.10b-5.
Trading on the basis of material, non-public information violates these sections when the trading occurs in connection with the breach of a fiduciary duty. Dirks v. SEC,
There are two theories under which a breach of fiduciary duty can be established such that a violation of Rule 10b-5 arises: (1) classical theory, and (2) misappropriation theory. SEC v. Maio,
The misappropriation theory "extends the reach of Rule 10b-5 to outsiders who would not ordinarily be deemed fiduciaries of the corporate entities in whose stock they trade." Cherif, 933 F.2d at 409. Under the misappropriation theory, a corporate "outsider" and his tippees can be held liable for the misappropriation of material, non-public information from its lawful possessor. Maio, 51 F.3d at 630; see also SEC v. Michel,
In his motion , Defendant Griffiths argues that the complaint fails to satisfy the pleading requirements of Rule 8(a)(2) because it fails to set forth sufficient facts to plausibly show that Griffiths (i) knew of material nonpublic information; (ii) misappropriated material non-public information; (iii) breached his fiduciary duty to FECI; and/or (iv) possessed the requisite scienter. Id. at 6. Defendant Griffiths' motion also argues that the complaint fails to satisfy the heightened pleading requirements of Rule 9(b) by "failing to identify Griffiths' particular role in the purported scheme, and instead attempting to hold Griffiths responsible for the conduct of other defendants." Id. at 13.
In addition to adopting the arguments made in Defendant Griffiths' memorandum,
After carefully considering the complaint, the parties' memoranda, and the relevant legal authorities, the Court concludes
A. Possession of Material, Non-Public Information
The SEC's complaint is based on its allegation that "[b]y the third week of March, 2007, both Gary Griffiths and Cliff Steffes knew that FECI was in the process of being acquired by another company," and the "fact that the company was for sale constituted material nonpublic information." Cmplt. at ¶ 2. Both motions to dismiss challenge this "conclusory" allegation as not pled with sufficient particularity to satisfy Rule 9(b), or even supported with sufficient facts such as to satisfy the plausibility requirement of Rule 8(a).
With respect to Defendant Griffiths, the SEC's allegation that Griffiths knew of the impending sale of FECI satisfies both Rule 8(a) and Rule 9(b). Unlike the typical insider trading case, Griffiths is not alleged to have been part of the confidential merger negotiations, or even directly informed of their existence.
Here, the SEC identifies what material non-public information Griffiths is alleged to have possessed (the knowledge that FECI was in the process of being sold), when he possessed this information (by the end of the third week of March 2007), and how he obtained sufficient underlying facts to reach that conclusion. Specifically, in "early March 2007," Griffiths' boss, FECR's CFO, asked him to compile a list of FECR's assets and their corresponding valuations. ¶ 34(a). This was the first time that this sort of information had been requested from Griffiths. Id. Drawing all
It is not obvious that a person who was asked to compile a list of assets, somehow became aware of yard tours occurring 300 miles away, and heard rumors that the company would be sold would come to the ultimate conclusion that FECI was in fact being sold. However, the SEC has certainly given Griffiths "fair notice" of its claim and "the grounds upon which it rests." Twombly, 550 U.S. at 555,
A number of additional considerations bolster the Court's conclusion that the SEC's allegation that Griffiths knew that FECI was up for sale is adequately pled. First, while the SEC has not pled facts that directly show that Griffiths knew in advance that FECI was up for sale, the SEC will never have to provide direct evidence of Griffiths' possession of material non-public information. Ultimately, the SEC may try to prove its insider trading claim through circumstantial evidence. See Herman & MacLean v. Huddleston,
Second, in addition to the supporting allegations found in paragraph 34(a)—(c), other portions of the SEC's complaint lend plausibility to the allegation that Griffiths possessed material non-public information before the family began trading. The SEC's complaint alleges that Griffiths' job put him in close proximity with FECI's President, Chief Operating Officer, and Chief Operating Officer, all of whom had knowledge of the sale. This too lends plausibility to the allegation that Griffiths might have learned of the sale by the third week of March. SEC v. Suman, 684
Third, the Court could not expect the SEC to allege precisely when and how Griffiths concluded that FECI was up for sale—only Griffiths would have those details. See SEC v. Scoppetoulo, 2011 WL 294443, at *3 (S.D.Fla. Jan. 27, 2011) (rejecting argument that insider trading allegation not properly pled under Rule 9(b), reasoning that "[a]llthough the SEC has not provided the precise words in the communications, the SEC's allegations, taken together with the Defendants' highly suspicious pattern of access to confidential information and subsequent stock purchases, is sufficient to survive Defendants' Rule 9(b) challenge."); Energy Factors, Inc. v. Nuevo Energy Co., 1991 WL 259425, at *4 (S.D.N.Y. Nov. 22, 1991) ("In cases involving insider trading, however, where the specific facts are `peculiarly within the knowledge of defendants,' the application of Rule 9(b) is `relaxed' to allow circumstantial evidence to plead the specific content and circumstances of insider tips."). In related fashion, at this early stage of the case, the Court can draw the inference that Griffiths believed that he had information that the market did not from the fact that close members of Griffiths' family invested a large portion of their collective liquid net worth in FECI stock after speaking with him. See Suman, 684 F.Supp.2d at 388 (allegation that defendant "possessed material non-public information" was "confirmed by [his] unusual timing and volume of trading") (emphasis in original).
In sum, as to Griffiths, the Court concludes that although the SEC's allegations are not robust, and that development of the facts through discovery may cast doubt on whether the information available to Griffiths truly was "material," "non-public," and intended to be available only for a corporate purpose, the allegations are sufficient to survive a motion to dismiss.
The analysis is similar for Defendant Cliff Steffes. The SEC alleges that Cliff Steffes (like his uncle) knew that FECI was in the process of being sold by the end of the third week of March 2007. While the underlying facts that lend plausibility to this allegation are admittedly thinner for Cliff Steffes than they are for Griffiths, they are sufficient to support a claim for insider trading at the pleading stage. Cliff Steffes allegedly knew "[b]y the end of the third week of March, 2007" that "there were an unusual number of daytime tours of FECR's Hialeah Yard involving a tour bus and people dressed in business attire." ¶ 37(a). We are not told specifically who told Cliff Steffes this, or how he otherwise learned it apart from the allegation that "there were regular communications among FECR's yard employees at various locations, and many rail yard employees who had not personally witnessed the
The motions to dismiss also argue that any facts that Griffiths and Cliff Steffes knew did not constitute "material" information. See, e.g. Griffiths Mem. at 8. Information is "material" in the § 10(b) and Rule 10b-5 context if there is a "substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." Basic Inc. v. Levinson,
As an initial matter, courts frequently have observed that questions of materiality are ill-suited to resolution of a motion to dismiss. See Levinson, 485 U.S. at 239, 108 S.Ct. 978 ("Whether merger discussions in any particular case are material therefore depends on the facts."); SEC v. Kornman,
Next, Defendant Griffiths argues that "the complaint fails to allege how and when Griffiths engaged in misappropriation or what he purportedly misappropriated." Griffiths Mem. at 9. Griffiths argues that the "only factual allegations in the Complaint relating to Griffiths' purported misappropriation are brief references to telephone calls between Griffiths and Rex C. Steffes. The allegations state the date of each call and what telephones were used, but do not identify the inside information, if any, allegedly exchanged during these calls." Id.
The Court agrees with Griffiths' assertion that "[m]ere telephone calls between family members, without more, do not plausibly support a conclusion that Griffiths misappropriated inside information." Id. However, the SEC's complaint contains more than just the fact that phone calls occurred—Griffiths overlooks the allegations that Rex C. Steffes engaged in suspicious trading shortly after his calls with Griffiths. Evidence of phone calls followed by such trading is sufficient to support a reasonable inference that Griffiths tipped Steffes in each of the phone calls that preceded the suspicious trades. See, e.g. SEC v. Ginsburg,
It is true that the SEC does not (and cannot) allege the specific content of the conversations between Griffiths and his brother-in-law Rex C. Steffes—those conversations were not wiretapped. But because that information is "peculiarly within the knowledge of defendants," the SEC need not "plead the specific content and circumstances of [the] insider tips." Aragon Capital Mgmt., LLC, 2008 WL 216320, at *3 (S.D.N.Y.2008).
C. Breach of Fiduciary Duty
Griffiths and Cliff Steffes do not deny that as employees of FECR, they each owed a fiduciary duty to their company.
Griffiths argues that the complaint "fails to allege the way in which Griffiths may have benefitted directly or indirectly from the disclosure." Griffiths Mem. at 11. Griffiths himself did not trade in FECI stock. And Griffiths points out that the complaint does not specifically allege that Griffiths knew that his family members would trade on the information that he provided. Id.
Nevertheless, the complaint adequately alleges a breach of fiduciary duty by Griffiths. It is well established that an insider who provides material nonpublic information to another may be found liable for insider trading, even if he or she did not personally buy or sell securities. See, e.g. S.E.C. v. Alexander,
The SEC has alleged that Griffiths' tips to Rex C. Steffes, his wife's brother, induced Steffes to trade and resulted in significant profits. Accordingly, it is reasonable to conclude that Griffiths received a personal benefit from making those tips, and the SEC was not required to plead that Griffiths received any direct financial benefit from tipping Steffes. See SEC v. Sekhri, 2002 WL 31654969, at *2 (S.D.N.Y. Nov. 22, 2002) ("Thus, when Sekhri disclosed insider information to his father-in-law, Sehgal, it may be inferred that Sekhri received some personal benefit from the gift of information."); see also SEC v. Kueng, 2010 WL 3026618, at *4 (S.D.N.Y. 2010). Further, it is a reasonable inference from the allegations in the complaint that Griffiths either knew or should have known that Rex C. Steffes would trade on the information that Griffiths had provided. See Griffiths Mem. at 11. The complaint also properly alleges a breach with respect to the tippee Defendants. See generally Maio, 51 F.3d at 632-33 (finding tippee knew or should have known of tipper's breach when he engaged in pattern of buying the corporation's stock after each phone call with the tipper).
For his part, Cliff Steffes' argues that the SEC has not alleged a plausible breach of fiduciary duty because none of the information allegedly possessed by Steffes was confidential corporate information that could not be shared with outsiders. Steffes Mem. at 13 (citing Maio, 51 F.3d at 632) ("Whether an insider's disclosure breaches his fiduciary duty to his corporation, and is therefore improper, depends
Accepting the SEC's allegations as true, Defendants signed codes of conduct, vowing to preserve the confidentiality of information learned during their employment and uphold their fiduciary duties to FECI shareholders. Through their jobs, Defendants allegedly gained an informational advantage over other shareholders and used it to their benefit when they traded and tipped.
Finally, Defendants argue that the complaint fails to plausibly allege that Defendants acted with the required scienter, which is an intent to deceive, manipulate or defraud. Aaron v. SEC,
Before the Court can consider this argument, it must resolve a dispute about what pleading standard the SEC must satisfy when pleading scienter. The Steffes Defendants argue that there is "a split of authority about whether a heightened pleading standard exists for allegations of knowledge in SEC enforcement actions" and invite the Court to adopt a rule whereby the SEC must plead facts giving rise to a "strong inference" that Defendants acted with the required state of mind. Steffes Mem. at 7. The Court respectfully declines the Steffes' invitation.
The Steffes' argument is based on the requirement under the Private Securities Litigation Reform Act ("PSLRA"), whereby certain private plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." See 15 U.S.C. § 78u-4(b)(2). In support of their argument that the strong-inference-of-scienter standard should apply not just to claims subject to the PSLRA, but also to SEC enforcement actions, the Steffes cite three cases from the District of Massachusetts (all decided by the same judge) which use "strong inference" language in the context of analyzing complaints in SEC enforcement actions. See SEC v. Durgarian,
Many "cases from across the country * * * stand for the proposition that the `stronginference' standard applies only to private securities actions," not enforcement actions such as this. Patel, 2008 WL 781914, at *5 (collecting cases); see e.g. SEC v. Falor, 2010 WL 3385510, at *3 n. 4 (N.D.Ill. Aug. 19, 2010) (citing 15 U.S.C.A. § 78u-4(b)(2) ("As a government entity, the SEC is not subject to the more stringent pleading standards imposed by PSLRA.")); SEC v. Lucent Techs., Inc.,
The complaint alleges that Defendants each "acted with scienter by trading and/or disclosing confidential information regarding FECI's pending acquisition when they either knew, or were reckless in not knowing, that they were doing so in breach of a duty not to trade on that information or disclose that information to others." Cmplt. at ¶ 71; see also id. at ¶¶ 65-69. While the above-cited scienter allegations are conclusory, those allegations are adequately supported by other facts alleged in the complaint. In an insider trading case, the Court may infer scienter from the circumstantial evidence. Herman & MacLean, 459 U.S. at 391 n. 30, 103 S.Ct. 683; Michaels v. Michaels,
For the reasons set forth above, Defendants' motions to dismiss [29, 36] are respectfully denied.
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